How banks works? History and risk associated to banks

Bank gets deposits from its deposit customers. Customers in return get interest. The number of people who deposit money is generally larger than lending customers(who takes loans). So the bank has enough money to pay interest(to depositors) and give loans(to lending customers). Lending customers have to pay an interest which is a larger amount. That becomes income to the bank. That is how banks earn to sustain their operations.

That is why when you deposit money we get very less interest. But when we take loans then we have to pay large money as an interest rate

How can a bank face a problem then?

The income of a bank relies on the money they get from lending customers. What if a customer fails to pay his debt? What if the number of such customers gets increased day by day. In these scenarios, their income will be affected and will create a problem for the economy. This is what we call the rise of NPA(Non-Performing Assets).

According to Reserve Bank of India NPA is-: An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank. A ‘non-performing asset’ (NPA) was defined as a credit facility in respect of which the interest and/ or installment of principal has remained ‘past due’ for a specified period of time.

So, Is it the only way to make money? Obviously no. There are plenty of ways a bank earn money.

How a bank make money?

Why banks were created?

In simple terms, if all the money in the hands of the public. Then the government will not be able to spend much for the growth of the economy. Government can’t rely on only taxes to spend for the country. Banks are reliable resources, trusted by both government and people. Thus can be utilized by people and government to get services.This way government and people will always have money. 

History of Banks in India

Formally started by Bank of Hindustan in 1770 but failed in the 1790s. The Indian banking sector is broadly classified into scheduled and non-scheduled banks. The scheduled banks are those included under the 2nd Schedule of the Reserve Bank of India Act, 1934. The scheduled banks are further classified into nationalized banks; State Bank of India and its associates; Regional Rural Banks (RRBs); foreign banks; and other Indian private sector banks. The term commercial banks refer to both scheduled and non-scheduled commercial banks regulated under the Banking Regulation Act, 1949. Imperial Bank of India in 1955 via State Bank of India Act considered as the first major step towards nationalizing of banks. But after that, no major step was taken up to 1969. During India Gandhi, nationalization wave came and major banks were nationalized.

The second phase of nationalization started in the 1980s. Now a total of 20 banks was in control of the government. Means more than 85% of banks were public sector. The major impact was that people start to have faith in the banks. 


The Reserve Bank of India was established in1935, in accordance with the provisions of the Reserve Bank of India Act, 1934.

The Central Office of the Reserve Bank was initially established in Calcutta. But was permanently moved to Mumbai in 1937. The Central Office is where the Governor sits and where policies are formulated.

Though originally privately owned. Nationalized in 1949. The Reserve Bank is fully owned by the Government of India.

Functions of RBI

Operational risk of banks

To know about Open Market Operations. click here.

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